How Do You React When Your Stocks Are Down?
There is a lot of money to be made when trading, however, losses are a fact of life for every stock market investor. The difference between successful traders and the rest is simply in how they deal with those losses. Its that strategy that will either make you money, or simply add to your losses.
The buy and hold method of trading large and small caps has been preached to and from the choir loft. Yet it is one thing to hear and know that this is a solid investment tactic and another thing in which to follow through when your stock has dropped 20 points during the course of a single afternoon.
If you have experienced a bear market, you know how difficult it is to stick with your original investment strategy. Should you sell now and protect your capital? Should you wait? Will it bounce? If you sell now will it bounce? Should I sell half now? Your emotions will often try and get the best of you. A good trader will control their emotions, and assess the current situation. What was the reason for the drop? Was there news released? Has the environment in which you are now trading in changed?
The buy and hold strategy requires discipline. Nerves of steel are also helpful. Most investors who risked more than they should will often head for the hills, and often make bad investment decisions along the way. Often, they will sell when they should have held, or held when they should have sold. Gain control of your emotions, and react accordingly.
If you have done your due diligence on your investment before you bought, then you should be able to weather the storm over the long term. As a matter of fact, the drop may provide the perfect opportunity to add to your position. Its important to remember that the buy and hold strategy works best with large cap stocks.
During bear markets, its perfectly normal for normally stable stocks to start to sell off. There are plenty of legitimate reasons, including, those who need to liquidate their positions (to buy a house, pay off some bills, go on vacation etc), to those who are looking to take some profits off the table. If your investment is up 50%, you too may be tempted to take some money off the table and invest it in something else. Since we don't know the motivation of the sellers, its something that we shouldn't spend too much time trying to figure out. Unless there has been news out that changes the direction of the company, its a safe presumption that the share price should continue to move higher.
We've put together 3 fundamental truths that should help you to weather the storm.
Its More Than Just A Sheet Of Paper
What you hold in your portfolio is a part of a company. Unlike day traders who buy and sell over the short term, hoping to make money by playing the up and down movement of the share price, long term investors are looking to own a piece of a company; to share in the story of the company. What your shares represent is a piece of everything the company owns. From pens to buildings, you own a portion of it.
Owning a portion of a company is no different than owning anything else. From a car to a home, whether you own it outright, or own it with someone else, in both cases, you need to do your due diligence. The price of everything fluctuates, whether its the value of a home, or a collectible hockey card, its value will move according to how the market is valuing the item. Stocks are no different. If you have researched, asked questions, and followed the movements of the share price, each of these actions has one thing in common: the do not involve emotion. If you let emotion dictate or influence your investing decisions in any way, you need to stay away from the stock market - you are going to lose money.
When a stocks share price moves lower, its for one of two reasons. Either the company has issued a material news release, which changes the variables you used to base your decision to buy on, or, for some reason that is not apparent at the moment. This is where you need to assess your position with a clear mind. Is this a signal of the future direction of the company, or, a great opportunity to add more shares to your portfolio at a great discount. You wont be able to make that assessment if you let emotions cloud your thoughts.
Second: If you are trading stocks with the big picture or the long haul in mind then you should look at a bear market and falling prices as a blessing rather than a curse. The only times these should profoundly effect you as a long term investor is when you have an immediate need for access to your money. If you look at it from this point of view, then declining prices only really indicate a good time to purchase more stock at a discounted price (more stock for the same money).
Whether your are trading large and small caps for the short term or long term, the following tips should help to improve your returns:
Make sure that insiders hold at least 20% of the company. The more insiders hold, the few the shares on the open market. The simple law of supply and demand dictates that the less there is of something, the more it is in demand. The fewer the shares out there, the better for you as the stock market investor.
If you use any variation of "I hope the price moves up", sell. Hope is an emotion. Save the emotion for ballgames with your kids, romantic dinners with your spouse or when you buy that kickin' new stereo. Emotion will turn a successful trade into a less than successful trade, and a loss into a greater loss.
Under most circumstances, the higher the rate of return, the higher the risk. Equities offer the highest amount of risk, however offer the highest amount of return. Cash offers the lowest amount of risk and the lowest amount of return. This is the trade off. During the last 50 years, equities have averaged around 10-11% per year while cash has only averaged around 4%.
Having a loss here and there in the stock market should be expected. It isn't how you deal the gains so much as how you deal with the losses you make along the way. If your ultimate goal in life is wealth then you are missing some of the greatest value that this world has to offer in your pursuit of that goal. Keep your investing goals realistic and honorable-be prepared to take hits along with the wins and learn to roll with the punches. That is what separates a successful investor from a failure as a person.
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